How To Get Growing Dividends From $573 Billion Annual U.S. Military Spending

| About: General Dynamics (GD)
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This post was written for Sure Dividend by Arie Goren

The United States military spends more than the next 11 largest militaries of the world combined.

What if you could turn the flow of your tax dollars around?

What if you could divert a portion of this $500+ billion annual cash stream into your own growing dividend income?

This article shows how to do just that by investing in shareholder friendly defense contractor General Dynamics (NYSE:GD).

General Dynamics ranks as a buy and current Top 10 stock using The 8 Rules of Dividend Investing thanks to its:

  • Low payout ratio of 33%
  • Low forward price-to-earnings ratio of 13.9
  • Better-than-average long-term expected growth rate of 9.0%

General Dynamics isn't the largest defense contractor (it's 4th largest in the world based on market cap), but it does have an enviable dividend history.

General Dynamics: The Shareholder Friendly Defense Contractor

General Dynamics has been paying uninterrupted dividends since 1979.

In March, the board of directors increased the company's quarterly dividend by 10.1% to $0.76 per share, representing the company's 25th consecutive annual dividend increase. General Dynamics may well soon become the newest Dividend Aristocrat.

Also, the company repurchased 7.8 million of its outstanding shares in the first quarter. The forward annual dividend yield is at 2.2%, and the payout ratio is only 30%. The annual rate of dividend growth over the past three years was high at 10.6%, over the past five years was also high at 10.4%, and over the last ten years was very high at 13.2%.

Since General Dynamics is generating much free cash flow, and the payout ratio is low, there is a very good chance that the company will continue to raise its dividend payment.

Source: company's reports *assuming same dividend rate for the year

General Dynamics Is Off To A Good Start in 2016

In December 2015, Congress passed an FY16 defense budget of $573 billion, $38 billion higher than the base recommendation. That helped lay the foundation for General Dynamics success in 2016.

The company has had a very good start to the year; better than its expectations. General Dynamics delivered strong first quarter results, and according to the company, it is ahead of the operating plan on which its guidance was based.

General Dynamics has been able to achieve growth in the last few years despite budget-cutting headwinds. In 2015, the company derived 55% of its revenues from the U.S. government, compared to 58% in 2014.

However, recent budget trends have been supportive for the industry.

Department of Defense forecasts calls for additional increases of 2% through 2020. The 2016 budget includes modernizing investments in such areas as nuclear deterrence, missile defense, cyber security and power projection. As such, that development will benefit the company.

On April 27, General Dynamics reported strong first-quarter 2016 financial results, which beat earnings-per-share expectations by $0.18 (8.3%). The company posted revenues of $7.72 billion in the quarter, also surpassing the consensus estimate of $7.68 billion.

GD has shown earnings-per-share surprise in all its last five quarters, as shown in the table below:

Source: Yahoo Finance

In the report, Phebe N. Novakovic, chairman and chief executive officer, said:

"General Dynamics delivered a strong first quarter, with all four groups contributing to our outstanding operating performance. We generated positive operating leverage and achieved the sixth straight quarter with operating earnings of more than one billion dollars."

Although General Dynamics' revenues have been flat in the last few years due to U.S. government budget cutting, in my view, it is very encouraging that the company has been able to grow profits by improving operating margins.

Revenue in the first quarter of $7,724 million was down 0.8% from the same quarter a year ago while operating earnings of $1,053 million were up 2.5% due to better operating margin which was up 0.4% year-over-year. Moreover, three of the company's four business groups expanded margins over the year-ago period.

Source: company's report

Rising margins will help to increase growth. The company's annual average earnings-per-share growth over the last five years was at 5.9%, and the average annual estimated earnings-per-share growth for the next five years is better at 8.8%.

General Dynamics has four primary business segments:

  • Aerospace
  • Combat Systems
  • Marine Systems
  • Information Systems and Technology

Segment revenues and operating earnings for the first quarter of 2016 are shown in the chart below.

Source: company's report

In addition, General Dynamics has a strong balance sheet. At the end of the first quarter, the company had cash and cash equivalents of $2.8 billion and total debt of $3.4 billion. The total debt to equity ratio was low at 0.32.

Net cash provided by operating activities in the recent quarter totaled $439 million. Free cash flow from operations, defined as net cash provided by operating activities less capital expenditures, was $374 million.

General Dynamics' Outlook & Backlog

According to the company, it does not, as a practice, change guidance at the end of the first quarter. It is its practice and has been for many years, to give a full review of its expectation at the midpoint of the year.

However, on the first quarter conference call, CEO Novakovic said that the company is ahead of the operating plan on which its guidance was based.

Management's initial estimates, established during the fourth quarter 2015 conference call, were for revenue of $31.6-$31.8 billion and an operating margin of 13.3%. Management also expected earnings-per-share of $9.20, up just 1% from 2015 due to higher expected interest expense, a higher tax rate, and currency headwinds.

However, General Dynamics has been conservative in its guidance which has resulted in beating expectations quarter after quarter. Therefore, I assume that the company will post better results for the year than those indicated in its latest guidance.

General Dynamics also had a massive backlog at the end of the first quarter, and it has gained some sizable contracts since then.

According to the company, there was order activity across the Gulfstream product portfolio and strong demand for defense products, which resulted in a book-to-bill ratio (orders divided by revenue) of one-to-one in the Combat Systems group and greater than one-to-one in the Information Systems and Technology group.

Total potential contract value, the sum of all backlog components, was $89.2 billion at the end of the quarter, compared to $90.6 billion at the end of the prior quarter and $96.1 billion at the end of the first quarter of 2015. Backlog according to company's segments at the end of the first quarter is shown in the chart below.

Source: company's report

Valuation & Final Thoughts

Since the beginning of the year, General Dynamics' stock is up 2.2% while the S&P 500 Index has increased 3.2%, and the Nasdaq Composite Index has lost 0.8%.

However, since the beginning of 2012, General Dynamics' stock has gained 111.3%, in this period, the S&P 500 Index has increased 67.7%, and the Nasdaq Composite Index has risen 90.7%. According to TipRanks, the average target price of the top analysts is at $158.60, an upside of 13% from its June 6 close price, which appears reasonable, in my opinion.

General Dynamics' valuation is good, the trailing P/E is at 15.2, and the forward P/E is low at 13.9. The price to sales is at 1.4, and the price to cash flow is at 12.7. Furthermore, the Enterprise Value/EBITDA ratio is very low at 9.6.

In addition, most of General Dynamics' Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median as shown in the table below.

Source: Portfolio123

General Dynamics has been able excel despite budget-cutting headwinds. However, recent budget trends have been supportive for the industry and will benefit the company.

In my view, General Dynamics' stock is an excellent candidate for diversified, large-cap dividend stock portfolio. The company recently raised its dividend by 10.1%, it generates strong free cash flow and returns substantial capital to its shareholders by stock buybacks and dividend payments.

The average target price of the top analysts is at $158.60, an upside of 13% from its June 6 close price, which appears reasonable, in my opinion.